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2006 10

Bank of England Governor Mervyn King uses the occasion of the Adam Smith Lecture to announce that Adam Smith will feature on the BoE’s new twenty pound note:

From the division of labour in the pin factory to the need for our mutual “sympathy” to be embodied in carefully designed institutions, Smith’s writing is remarkable by its comprehensive and eclectic examination of ideas and facts. So it is appropriate that tonight here in Kirkcaldy, where Adam Smith found contentment in study and reflection, I can announce that tomorrow the Bank of England will reveal its new £20 note. And the figure celebrated on the new note will, of course, be Adam Smith - the first economist and the first Scotsman to appear on a Bank of England note.

From next spring, when visitors to our country look carefully at their new £20 notes, they will be able to see an engraving showing the division of labour in pin manufacturing with the words “and the great increase in the quantity of work that results”. I hope they will absorb the lesson that specialisation in production and trade across the world are the way to improve living standards in all countries – rich and poor alike. And perhaps when they return home they will press their own politicians to support the opening up of trade which has been at the heart of the British Government’s efforts to reform the world economy.

Alan Reynolds, who often gets a favourable mention on these pages, has a new book out, Income and Wealth:

This volume explains the dynamics of income generation, how it is measured, and how such dramatic disparities in distribution come about. Citing numerous cases of distortion in the popular press, and among academics, policymakers, and pundits, Reynolds exposes many popular myths concerning income and wealth, and presents a balanced perspective on this critical aspect of economics and social policy. The book first defines various characteristics of income, with an emphasis on the gap between the rich and the poor, and reviews several theories to explain the disparities. Subsequent chapters focus on such timely topics as the “vanishing” middle class and the sky-high salaries of CEOs, Hollywood stars, and athletes. The final chapters consider the implications of policies, such as the minimum wage, taxes, immigration, and trade quotas, and expand the discussion to consider international comparisons. Featuring graphs and charts, a glossary of key terms, and a listing of references and resources, Income and Wealth explains the intricate, and often controversial, effects of economic policies on individuals, families, and communities. Moreover, it demonstrates how the numbers can be manipulated by policymakers, pundits, journalists, and academics to promote various agendas, and shows readers how to recognize hyperbole and make better-informed decisions.

It’s hard to know what aspect of this book (extracted in Der Spiegel) is the scariest: the mercantilist assumption of a ‘world war for wealth,’ arguing for a multilateral US-EU FTA as an economic NATO against a bizarre caricature of the East, or the fact that the ‘best-selling’ author was ‘Economic Writer of the Year’ in 2004. Then there are laugh-out-loud statements like this:

The EU Commissioners are the last true believers in the religion of free trade.

It does serve to illustrate that mercantilist thinking is extremely resilient, not least in Europe, and that arguments for free trade are never entirely won.

While most journalists remain preoccupied with monetary policy outcomes at the expense of processes, at least some journalists remain interested in the procedural aspects of monetary policy formulation:

These outside [RBA Board] members are already expected to leave their private and business interests at the boardroom door. Publishing the minutes would only confirm this, wouldn’t it?

To insist on secrecy, ostensibly to protect the commercial sensitivities of board members’ comments in the course of debate, begs the perception, at least, that they may have something to hide. It also hints that the real reason may be to keep under wraps the occasional board conflict over rate decisions.

The Reserve Bank has come a long way from the obscurantism of the past. And, undoubtedly, the present approach has served Australia well in the way the bank has conducted policy in the past decade.

But shedding even more light on its decision making by publishing its board deliberations could only help Australians better understand where their mortgage payments and business borrowing costs are headed, and why.

The Australian Treasury’s David Gruen and Steven Kennedy have prepared a useful comparison of housing cycles in Australia, the UK, the Netherlands and the US. Gruen and Kennedy make the simple point that the US housing cycle has been relatively muted compared to the experience of other countries. It follows that the broader macro implications of the US housing downturn should also be more muted than in these broadly comparable countries.

Gruen and Kennedy conclude:

Somewhat like the UK, US consumption growth rose only modestly above its longer run average during the housing price upswing. This again suggests that the US consumption slowdown might also be relatively modest…

it seems reasonable to expect a sharp cooling in the US housing market to generate a noticeable slowing in US economic growth over the next year or so. But it is hard to imagine a cooling in the US housing market, on its own, generating a US recession. For such an outcome to eventuate would, it seems to me, require some significant other adverse shocks – of the kind that hit the Netherlands economy at roughly the same time that its housing market was unwinding.

The U.S. population will hit 300 million at 7:46 on Tuesday morning, says the Census Bureau. But it’s the 400 million milestone, which the U.S. will reach in about 35 years, that has demographers and economists really talking.

Those additional 100 million people, many of them immigrants, will replace aging baby boomers in the work force, fill the Social Security coffers and, in all likelihood, keep the economy vital…

The Census Bureau says the U.S. population will grow by a further 34% by midcentury, even as Europe’s population shrinks by 8% and Japan contracts by 9%. As Columbia’s Mr. Prewitt puts it: “It’s deep in our culture to grow.”

On average, over the past 50 years residential investment has accounted for a bit under 5 percent of GDP. That’s about a third more than businesses spend building factories, offices, and commercial space, but in the same ballpark as how much households spend on recreation, which includes items such as golf clubs, football tickets, and, as the Commerce Department likes to call it, legitimate theatre and opera.

Five percent of GDP sounds small; but residential investment also is highly volatile, and over shorter periods of time it can influence GDP growth a good deal. For example, residential investment increased more than 25 percent and accounted for a full percentage point of GDP growth in 1976. But it fell at close to a 20 percent rate during the twin recessions in 1980 and 1981 and subtracted nearly a percentage point from growth in each of these years.

It’s important to remember, though, in the early 1980s mortgage rates were almost 20 percent and the unemployment rate reached nearly 11 percent. The drop in housing then largely was the result of these macroeconomic influences, and not the cause of them. That is, the recessions did not occur because residential investment fell so much; rather, the factors that caused the recessions also resulted in sharp declines in residential investment.

A CEDA Information Paper by Nic Gruen argues for a reduction in the company tax rate, to be funded by the abolition of dividend imputation. Gruen makes the point that the focus on aligning the company and personal tax rates has little support in economic theory and has led to an excessive focus on personal income tax cuts at the expense of reducing taxes on capital. I would make a similar argument in relation to capital gains tax, although Gruen’s paper does not address the issue and his evidence does not necessarily generalise to the case of CGT. For a good paper arguing in favour of the reduction in CGT in the Australian context, see Alan Reynolds’ 1999 report for the ASX, which examines the dubious intellectual foundations of the idea that we should tax capital gains.

Gruen argues for caution in interpreting some of the work coming out of the AEI on company tax, on the grounds that it might reflect their ‘free market ideology.’ As I have had occasion to point out previously, the economists at AEI are well to the left of Australian social democrats on some issues and to the left of some notionally ‘liberal’ (in the US sense of the term) US think-tanks like the Institute for International Economics. Even the Cato Institute has had some notable lapses, such as inviting Nouriel Roubini to its monetary policy conference last year. Some of the work coming out of the AEI should indeed be approached with caution, but not for the reasons suggested by Gruen!

Reserve Bank of Australia Governor Glenn Stevens, on the housing downturn in the US:

With the effects of a buoyant housing market thought to have been an important expansionary force in the US in earlier years, the recent change in sentiment in that market is understandably regarded as significant. Australian experience suggests, as does that of the UK, that the end of a housing price boom can have noticeable effects on aggregate demand. But those experiences also suggest that such effects are manageable. In Australia’s case, the resources boom coincided with the housing moderation and helped to dampen its effects, but that has not been the case for the UK, which has had broadly similar economic outcomes to our own. On this basis, one would think that there are reasonable prospects for moderate growth in the US economy in the period ahead. But this is obviously an area of uncertainty, and even a favourable outcome involves slower growth in US aggregate demand in the future than we have tended to see over most of the past decade.

Mullah Hamilton’s puritanical Australia Institute is fond of media stunts, but its latest report into what it calls ‘corporate paedophilia’ has clearly overstepped the mark:

Sydney mother Louise Greig was baffled and upset to be included in the “corporate pedophilia” report for photographing her daughter Georgina to promote her business, “tween” clothing label Frangipani Rose.

Ms Greig said the report said “much more about [the Australia Institute’s] Dr Emma Rush than it says about us”.

“The idea that you can look at a photograph that I’ve taken of my own daughter and think, that’s pornography - what goes though that woman’s mind?” she said.

“What kind of planet does she live on, that she would think such sick thoughts?”

Ms Greig said she felt ill whenever she thought about the way Dr Rush had described her nine-year-old daughter as “leaning forward, with legs astride. Both pose and angle are reminiscent of porn shots”.

“The more I think about how the authors have psychoanalysed and viewed my daughter’s photo in a pornographic sense makes me feel sick to the stomach,” Ms Greig said.

“I feel defamed and vilified but thankfully my daughter is too young and innocent to understand that she has been exploited by Emma Rush.”

Kevin Hassett argues that US Q3 GDP may play a role in the upcoming US congressional elections:

here is the kicker for Republicans: The data calendar indicates that GDP for the third quarter will be reported by the Bureau of Economic Analysis on Oct. 27, right before Americans enter the voting booths.

You might call it the “October surprise,” but in this case, economists will have seen it coming. Republicans, who have found themselves in the political equivalent of a nightmarish ballgame for some months now, will probably not be surprised that this break has gone against them as well.

My associates at Action Economics are arguing that any ‘October surprise’ will be up:

The market seldom watches U.S. wholesale trade reports, but this morning’s figures have revealed a robust growth trajectory for both sales and inventories that has further reduced prospects for a meaningful slowdown in GDP growth in Q3, as some still fear. We have not revised our 2.7% GDP growth estimate for Q3, but economists focused on a “1-handle” will have difficulty supporting such low forecasts.

I fully agree that oil prices will remain high for a long time; worse, they are likely to significantly rise towards $100 in the medium term (and some are already expecting oil at $90 by year end). Indeed, the factors that [Robert] Feldman suggested that may lead to lower oil prices in the future are all unlikely to take place. So, expect higher and higher oil prices and, at some point, another ugly stagflationary outcome.

Nouriel has only ever been interested in one story: his perverse hankering for macroeconomic ruin for the United States.

Jim Cramer notes that reports of the death of the US consumer are greatly (and frequently) exaggerated:

As a former obituary writer, I know that you must call the funeral parlor to make sure a person’s dead before you pronounce him so in the newspaper. So would it be too much to ask if economists, analysts and hedge-fund managers did the same before pronouncing the American consumer dead? In 25 years of trading stocks, I’ve read the consumer’s obituary more times than I care to imagine; each time the facts have proven the obit premature. For the last year, though, the negative-pundit nexus has unleashed a fusillade of consumer death notices…

It’s time for these permanently pessimistic pundits to accept the market’s judgment. If I’d ever written a premature obituary, I’d have been fired before the delivery boy could toss the papers from his bike. But these saturnine soothsayers just get to repronounce a new slaying on the next piece of data that hits the wires. Perhaps, at last, after these sparkling reports right on the heels of a year’s worth of death notices, we should at last recognize who’s worth listening to—and, especially, who’s worth ignoring.

Speaking of permanently pessimistic pundits, only Nouriel Roubini could attempt to put a bearish spin on the September non-farm payrolls release, which was better than expected in level terms and foreshadowed a massive 810k upward benchmark revision to the level of employment.

Nouriel Roubini attempts to argue that the benign experience of housing booms and subsequent downturns in rest of the Anglo-American world fails to invalidate his US recession calls based on a downturn in US housing.

First, Nouriel tries to argue that central banks in the UK, Australia and NZ have been more pro-active in targeting asset prices, in this case house prices, than the Fed. This is mere assertion on Nouriel’s part. The BoE, RBA and RBNZ have certainly referenced housing as one of many factors behind their recent tightening cycles, but all three central banks view their conduct of monetary policy as being squarely within the standard Taylor rule framework and are just as cautious as the Fed about the notion of central banks targeting asset prices. Indeed, if these central banks have been targeting house prices, they have done a lousy job of it. House price inflation in the rest of the Anglo-American world has if anything been even more pronounced than in the US and remains strong in NZ (this is ironic, because the RBNZ has actually given the strongest emphasis to housing in its official rhetoric). I highly recommend Adam Posen’s paper on the subject for a thorough debunking of Nouriel’s argument that monetary policy should target asset prices. Ben Bernanke also gave a speech on the subject before becoming Fed Chairman, in which he demonstrates how dangerous and misguided it would be for central banks to attempt to manage asset prices. To argue that the Fed is completely out of step with the rest of the world in its conduct of monetary policy simply beggars belief. If anything, the US under Volcker, Greenspan and Bernanke has set the standard that was subsequently emulated by other central banks by the adoption of formal inflation targets that sought to match the Fed’s record on inflation.

Second, Roubini argues that ‘What prevented a hard landing of the economy in the UK, Australia and New Zealand has been – among other factors – the fact that all three countries have experienced sharp positive terms of trade shocks that have boosted overall GDP at the time when the housing market was going into a sharp slump following the bursting of their housing bubbles.’ This statement somewhat contradicts his first argument that the soft-landings in these countries were a function of monetary policy. But it also ignores the fact that these terms of trade booms are not nearly as important to measured GDP growth as many people assume. The sectoral composition of the other Anglo-American economies is little different from that of the US, being overwhelming in services. Strength in commodity prices should not be confused with strength in commodity output, which is what real GDP measures. As we have noted previously, mining output in Australia fell 8.3% in the year to June. Net exports have made a flat or negative contribution to Australian GDP growth in every quarter since Q3 2001. As John Edwards likes to point out, Australian export volumes have even underperformed US export volumes. The increased national purchasing power due to a rising terms of trade has resulted in the substitution of imports for domestic production, which actually subtract from GDP, so terms of trade booms have mixed implications for measured GDP growth. Perhaps the best measure of the lack of importance of commodities for the overall Australian economy is the simple fact that some of the strongest GDP growth rates in the current Australian expansion were achieved during the 1998-2001 global commodity price slump.

after looking at all the housing bubbles [sic] all over the world in the past decade, it’s hard to find a single one that has yet resulted in a hard landing. Nouriel seems to be saying that Australia, New Zealand, and the UK are all somehow special cases, but in fact, to me, they actually seem closer to the norm. Could the United States have a hard landing? Of course it could. But that would make it the exception, rather than the rule.

A Bloomberg story hints that the recent departure of Morgan Stanley Sinophile and ‘bubble’ drone Andy Xie may have had something to do with an internal email he wrote attacking Singapore as the host of the recent IMF and World Bank annual meetings. According to Bloomberg:

He questioned why Singapore was chosen to host the conference and said delegates “were competing with each other to praise Singapore as the success story of globalization.”

“Actually, Singapore’s success came mostly from being the money laundering center for corrupt Indonesian businessmen and government officials,” said Xie, who was based in Hong Kong before leaving Morgan Stanley on Sept. 29. “Indonesia has no money. So Singapore isn’t doing well.”…

“I tried to find out why Singapore was chosen to host the conference,” Xie wrote in the e-mail. “Nobody knew. Some said that probably no one else wanted it. Some guessed that Singapore did a good selling job. I thought it was a strange choice because Singapore was so far from any action or the hot topic of China and India. Mumbai or Shanghai would be a lot more appropriate.”

At a dinner party hosted by Singapore Prime Minister Lee Hsien Loong, “people fawned him like a prince,” Xie wrote. “These Western people didn’t know what they were talking about,” he wrote.

‘Chairman’ Roubini, interviewed on CBS. As Brad Setser suggests, Nouriel is not quite as outrageous on television as he is on his blog, where he is describing the current rally in US equities to new all time highs on the Dow as a ‘delusional sucker’s rally.’ When analysts start describing markets as irrational, it’s usually a good indication that the market is in the process of invalidating their macro view.

Rather than assuming that millions of equity investors are delusional, James Hamilton attempts to reconcile the apparent divergence in equity and bond markets:

stock prices reflect both expectations of future profits as well as current interest rates. A lower real interest rate means that the present value of future earnings has increased even if the earnings themselves are no higher, because future flows are discounted less. Furthermore, the stock market has always exhibited an aversion to inflation as well. Hence, even if investors’ forecasts of future profits had not improved, one might still expect to see stocks appreciate as a direct result of a lower real interest rate and lower expected inflation. In other words, part of the stock market rally could be viewed as the logical companion of that for bonds. But the magnitude of the stock market surge seems too large to attribute to this alone, and certainly is grossly inconsistent with the assertion that investors believe the U.S. is about to enter a recession…

Current fed funds futures and option markets are betting that the fed funds rate will be down to 5% by next spring. And yet, in public statements the Fed seems to be communicating that, if it makes any changes, it is more likely to be toward higher rather than lower rates.

Well, here’s a story that I believe could reconcile everything. The housing slowdown is significant, real, and upon us now, but this is as bad as it’s going to get. Inflation numbers will begin to look better, allowing the Fed some breathing room to bring rates down slightly, averting a complete meltdown in housing. We get slower real economic growth, the biggest burden of which is borne by homebuilders. But the benefits of taming inflation bring some cheer to the rest of Wall Street and perhaps Main Street.

In other words, markets seem to believe that Bernanke is going to pull off the soft landing after all—slower real growth for sure, lower inflation, but no recession.

While this blog likes to make fun of economists who perpetually forecast gloom and doom, at least most economists would generally concede that secular trend is up, whatever the cyclical ups and downs along the way.

By contrast, Kurt Andersen notes an apocalyptic zeitgeist that seems to unite ‘Christian millenarians, jihadists, Ivy League professors, and baby-boomers:’

Not so long ago, it was only right-wingers and old crackpots making decline-and-fall-of-Rome claims about America. But Niall Ferguson is a young superstar Harvard professor, and he argues that we—undisciplined, overstretched, unable to pay our bills or enforce our imperial claims, giving ourselves over to decadent spectacle (NASCAR, pornography), and overwhelmed by immigrants—do indeed look very ancient Roman. He suggests, in fact, that Gibbon’s definitive vision—the “most awful scene in the history of mankind”—is about to be topped.

Andersen suggests that this preoccupation with apocalyptic scenarios may partly come down to baby-boomer pathology:

It’s also a function of the baby-boomers’ becoming elderly. For half a century, they have dominated the culture, and now, as they enter the glide path to death, I think their generational solipsism unconsciously extrapolates approaching personal doom: When I go, everything goes with me, my end will be the end.

It should be said that economists are not entirely off the hook in terms of being excessively pessimistic, as this paper by Robert Fogel notes:

At the close of World War II, there were wide-ranging debates about the future of economic developments. Historical experience has since shown that these forecasts were uniformly too pessimistic. Expectations for the American economy focused on the likelihood of secular stagnation; this topic continued to be debated throughout the post-World War II expansion. Concerns raised during the late 1960s and early 1970s about rapid population growth smothering the potential for economic growth in less developed countries were contradicted when during the mid- and late-1970s, fertility rates in third world countries began to decline very rapidly. Predictions that food production would not be able to keep up with population growth have also been proven wrong, as between 1961 and 2000 calories per capita worldwide have increased by 24 percent, despite the doubling of the global population. The extraordinary economic growth in Southeast and East Asia had also been unforeseen by economists…

One of the points [Kuznets] made was that if you wanted to find accurate forecasts of the past, don’t look at what the economists said. The economists in 1850 wrote that the progress of the last decade had been so great that it could not possibly continue. And economists at the end of the nineteenth century wrote that the progress of the last half century has been so great that it could not possibly continue during the twentieth century. He said you would come closest to an accurate forecast if you read the writers of science fiction.